Share of the Week: Record year for high yield retailer

With only one double-digit casualty, the FTSE 350 displayed a healthy performance this week as G4S, Entertainment One and Restaurant Group rallied together to push the index 2% higher. But it was furniture retailer DFS that stole the show, surging 22% after confirming that 2016 was another record year and it would return up to half of its profit back to shareholders. The stock is trading on a 4.5% yield.

Collapsing 40% to an all-time low of 177p after the Brexit vote, this week's rally has pushed the shares to an two-month high of 260p and firmly on the recovery path. Compared to its 2015 peak of 350p, DFS has now smashed through its crucial 38.2% Fibonacci retracement and is now using 50% as resistance. The next crucial level in this recovery is 61.8%, in line with Numis Securities 280p target price.

Early delivery on growth initiatives - including store expansion and product improvements - underpinned a strong second-half performance, which should deliver 7% revenue growth in the year to 30 July.

Management are preparing for a record year with pre-tax profit expected at the upper end of £60.7-64.6 million guidance. Numis has upgraded its forecasts 2% to £64 million.

Although its Sofa Workshop and Dwell subsidiaries generated around 1% of revenue, their limited scale, launch costs and investment spend weigh their margin below the group. Dwell has adopted a new store-in-store warehouse concept to drive profitability in 2018.

Sales should reach £755.5 million in 2016 in October's full-year results, reckons Numis, with pre-tax profit of £64 million giving earnings per share of 23.7p.

With strong free cash flow and shrinking net debt – it is now below 1.5x cash profit - investors should look forward to getting up to 50% of profit after tax back through a final dividend. Yielding 4.5% for 2016 and 4.8% for the year after, shareholders should receive 11.3p and 11.9p per share respectively.

It's been just six weeks since Britain voted to leave the European Union, so the group is wary of predicting long-term trends, but so far there has been no impact on demand. There are still hurdles ahead in the form of the increased risk of a market slow down, cost pressure from currency headwinds and higher competition.

Still, conservative analyst Matthew Taylor has inched his 2017 forecasts 2% lower to £792.5 million sales, pre-tax profit of £67.5 million and earnings per share (EPS) of 25p.

"We are encouraged that sales have so far seen little impact from the EU referendum, although we think it would be unrealistic to expect big-ticket demand to remain unaffected over the coming year. We view this rally in the share price as justified and see further upside in the valuation," said Numis analyst Matthew Taylor.

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